Tensions set to grow as Europe lags in vaccinations and fiscal support
This week we’ll look at the contrast between Europe and the US in terms of the vaccines and the economy, and Europe does not come out well. That’s Europe ex UK, because we’re in a quite a different position – different in good ways and bad.
First, the vaccine roll-out: proceeding apace in the US, stumbling in Europe. Second, fiscal stimulus: massive in the US, actually contracting in Germany where VAT has just gone up, and more or less neutral elsewhere in the eurozone. We’ve seen confirmation of the superior US economic performance in the data on GDP – contracting in Q4 in many European countries, and likely to contract further in the current quarter, but expanding robustly in the US. We can also see it in earning reports; for the S&P 500 over 80% of companies have beaten analysts’ estimates for earnings – with an aggregate beat by almost 20%. They’ve also beaten on revenue. In Europe, the beats are less impressive.
Now there is a worry in the US that the UK variant could get a grip and lead to another big wave of the virus. But this hasn’t happened yet and as more and more of the population are vaccinated – 10% of the population have now had their jab – the pressure on health care systems should ease. Provided the virus is contained, we should see restrictions gradually eased from next month onwards. Remember it’s largely up to individual states when it comes to lockdowns. With much of last year’s fiscal stimulus still sitting in people’s bank accounts, the pent-up demand is huge. I expect to see a real boom in the US this year.
Inflation worries could overshadow the improving prospects for the US economy
Booming demand is good news for corporate profit margins, and I expect to see earnings beat pre-Covid levels by the end of this year. That’s good news. But it won’t be plain sailing because fears of inflation are on the rise in the US. 10-year breakeven rates have hit 2.1%, up from 1.6% before the vaccine news broke last autumn, and up from a remarkably low 0.55% in the dark days of last March. Headline inflation is set to rise to close to 3% in the next few months, due partly to base effects. And with such a surge in demand, there’ll be price rises more generally. This shouldn’t translate into a sustained rise in inflation. And remember that the Federal Reserve actually wants inflation to sustain a move above 2% to offset the many years that inflation has been below their 2% target. But markets will be worried until they see inflation pressures dissipate. So, it’ll be a battle between better prospects for earnings and the economy, versus fears of high bond yields. Volatility seems likely to remain elevated, even without the “WallStreetBets” community of retail investors.
Bad luck and bad planning hampers vaccine progress in Europe
The vaccine roll-out in the US is well ahead of Europe, but the UK is proceeding even faster. Notwithstanding the PR disaster by the European Commission last week, it is clear that a combination of bad luck and bad planning means that Europe looks set to fall further behind the UK in the coming weeks. At their current pace of vaccination, it will be several months before Europe catches up with where the UK is today.
The UK has suffered disproportionately badly in the pandemic so far, with a higher rate of deaths directly and indirectly from Covid than any other major country. But the vaccine roll-out is going extremely well. The government is focused on hospitalisations – the pressure on the NHS. And we are about to see a major turn here. The numbers in hospital with Covid should peak this week and then tumble as a result of the severe lockdown and the widespread vaccination of the clinically most vulnerable. Efficacy rates will be lower given the UK’s one dose strategy and are almost certainly lower than reported in the trials for the very elderly, but remember that those rates referred to the risk of getting symptoms. Efficacy rates on preventing hospitalisations were close to 100% for the AstraZeneca, Moderna and Pfizer vaccines.
A staycation in Cornwall could cost you an exotic price
As a result, we expect restrictions to begin to be eased from next month, with some schools and non-essential shops reopening. In April, leisure and hospitality should follow. Restrictions will still be in force, but I hope to be able to enjoy a glass of lemonade after a round of golf by Easter. One area where restrictions might last much longer is foreign travel. The UK government will do all they can to keep the South African and Brazilian variants out of the UK – because they weaken the efficacy of vaccines. And as staycation demand is set to soar this year in the UK, watch out for price jumps – a holiday home in Cornwall might seem like a compromise but you could pay an exotic price.
Tensions could rise between the UK and Europe
So, the outlook in the UK and US is positive, and this will raise the frustration of businesses and individuals in Europe. Tensions will rise. We will see setbacks if and when mutations challenge the vaccines. We look set to suffer from this virus for years to come. But the tide has turned and we can look forward to getting back to something like normal as the year progresses. That should be good for risk assets. Let’s hope we can start worrying more about issues like inflation and fiscal deficits and less about counting the grim toll taken by this terrible pandemic.